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Late last year, the U.S. Securities and Exchange Commission (SEC) adopted a new set of rules requiring the majority of trades in the $26 trillion U.S. Treasuries markets to be cleared through a central counterparty clearinghouse. Coupled with new regulations that expand dealer registration requirements, the changes represent arguably the most significant overhaul yet to the structure of the world’s largest and most liquid market. The new rules are set to be phased-in beginning in March 2025, with Treasury cash clearing beginning December 31, 2025, and repo clearing beginning June 30, 2026.
For those of us who were around to see a similar-looking mandate introduced in the interest rate derivatives markets as part of the Dodd-Frank Act following the 2008 financial crisis, there is a feeling of deja vu. Back then it seemed all anyone could talk about was fears that: swaps liquidity would grind to a halt; increased trading costs would put entire industry segments out of business; and overreliance on clearinghouses would create new systemic risks. Thankfully, those fears did not materialize.
Perhaps because we’ve all now lived through more than a decade of smooth operation in centrally cleared swaps markets and steady growth of electronic swaps trading, or maybe because the Treasury clearing mandate was ultimately narrower than many in the industry had initially anticipated, much of the fear-mongering that came along with Dodd-Frank has been absent this time around. Still, despite the relative calm with which the news was digested, lingering concerns about clearing capacity and ever-growing capital requirements for the banks are very much a factor for market participants as they prepare for upcoming central clearing deadlines.
Clearinghouse Access and Trading Costs
When it comes to the Treasury clearing portion of the mandate, a primary concern is the threat of increased trading costs. Strategists at Deutsche Bank were quoted in the Financial Times saying, “On the flip side, dealers will face higher clearing costs, which they may pass down to customers in the form of wider spreads.”
It’s still anyone’s best guess which clearinghouses will ultimately launch Treasury clearing offerings and what clearing model(s) they will employ. Today, Fixed Income Clearing Corporation (FICC) is the only clearing agency for U.S. Treasury transactions. At FIA Boca in mid-March 2024, however, CME announced their plan to enter the space, and we understand that other existing clearinghouses are also focusing closely on the U.S. Treasury market.
There are also unanswered questions about who, exactly, will need to clear, which is dependent to some extent on the implementation of SEC’s expanded broker-dealer rule. Under the new clearing rules, all U.S. Treasury trades between members of a clearinghouse and registered broker-dealers, and any trades made via an interdealer broker must be cleared. Most bank dealers in this market are direct members of FICC and currently clear their trades there. However, under these new rules, other participants, such as Proprietary Trading Firms (PTFs), who may need to register to become broker-dealers, will need to start clearing their trades. This expanded broker-dealer rule, it’s worth noting, is currently being challenged.
In other markets, participants who are not direct participants of a clearinghouse can only access the clearing agency through another market participant who is a direct participant, usually through a “sponsored” or futures commission merchant (FCM) model.
Implementing these types of models in the U.S. Treasury space raises questions about commercial viability. The banks who traditionally offer services to sponsor non-banks at a clearinghouse may find that these businesses are not commercially compelling, especially if they are required to hold more and more capital. As a result, indirect participants may find it challenging and expensive to contract with banks to access a clearinghouse, which could result in increased overall trading costs to indirect participants.
Market Resiliency and Liquidity
As discussed above, the potential for increased costs could have an unintended impact on the U.S. Treasury market. Widely regarded as the most liquid marketplace in the world, any incremental slowdown in that liquidity could create significant knock-on effects in adjacent markets, and more urgently, affect the U.S. government’s ability to fund itself. Liquidity in U.S. Treasury markets is critical in all market conditions, but the consequences of illiquidity can be particularly acute during times of volatility or market stress.
The market disruptions at the beginning of the COVID crisis in March 2020 clearly illustrate this issue. The introduction of central clearing would not alleviate liquidity constraints such as those seen in March 2020, and to the contrary, there is an argument that the obligation to meet increased margin and collateral calls during these times would introduce greater stress into the system and ultimately diminish liquidity even further.
Part of that will come down to how access to FICC, or a new-entrant clearinghouse, is either encouraged or disincentivized. This will depend on whether or not commercial terms and/or netting arrangements can be leveraged to make clearing terms more attractive for market participants. DTCC and CME have made headway in this space, but as CME and other clearinghouses pursue their own clearing offerings, other solutions may also emerge.
On the flip side, it is possible that, depending on exactly how the details of the clearing mandate are implemented, the requirement could increase dealer capacity in certain markets. Netting, for example, whereby the clearinghouse can aggregate several trades to reduce overall risk exposure, could reduce dealer capital and balance sheet capacity attributed to specific trades, giving the dealer the ability to enter into additional transactions.
For this benefit to be realized, however, the SEC and market participants will need to understand and consider precisely how any clearing mandate would affect with the relevant capital and accounting rules, as well as regulatory initiatives still in flight such as Basel III Endgame. In either scenario, it is important to recognize that the detailed mechanics of the clearing process could have a material impact on overall liquidity in U.S. Treasury markets.
What’s Next
Just as we saw with the central clearing of swaps, the next several months will be filled with conversations on the specific details of implementation, which will collectively determine the long-term impacts of the Treasury clearing mandate on counterparty risk, trading costs and liquidity. Tradeweb’s deep presence across institutional, wholesale and retail markets position us well to help our clients navigate these upcoming changes. Over the next year, we will continue to work closely with dealers, customers, clearinghouses, and regulators to ensure a seamless clearing process on our platforms. We’ll also provide updates every step of the way to ensure our clients are ready to address any new details as they emerge. This will include updates around the central clearing mandate as it relates to repo transactions in U.S. Treasuries, and what these regulatory requirements mean for market participants trading repo and our industry more broadly.
About Tradeweb Markets
Tradeweb Markets Inc. (Nasdaq: TW) is a leading, global operator of electronic marketplaces for rates, credit, equities and money markets. Founded in 1996, Tradeweb provides access to markets, data and analytics, electronic trading, straight-through-processing and reporting for more than 50 products to clients in the institutional, wholesale and retail markets. Advanced technologies developed by Tradeweb enhance price discovery, order execution and trade workflows while allowing for greater scale and helping to reduce risks in client trading operations. Tradeweb serves more than 2,500 clients in more than 70 countries. On average, Tradeweb facilitated more than $1.4 trillion in notional value traded per day over the past four quarters. For more information, please go to www.tradeweb.com.
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